Pub. 11 2016-2017 Issue 3

www.nebankers.org 12 Extraordinary Service for Extraordinary Members. COUNSELOR’S CORNER CECL: Accounting for the Future by Preparing Today Jeff Makovicka, Kutak Rock LLP I F YOU HAVEN’T HEARD, BANKS ARE preparing for a transition to new rules for estimating credit losses which require “reasonable and supportable forecasts about the future.” The Financial Accounting Standards Board’s (FASB’s) recent Accounting Standards Update 1 sets out a new loss impairment model, the Current Expected Credit Loss (CECL). FASB is replacing the current “in- curred loss” accounting model with an “expected loss” model—CECL. This will require banks of all sizes to anticipate, rather than react to, problems in their loan portfolios. At least one industry authority has referred to CECL as “the biggest change ever to bank account- ing.” 2 Under the new CECL model, banks are required to use historical informa- tion, current conditions, and reasonable forecasts to estimate the expected loss over the life of the loan . 3 The transition to the CECL model will bring with it greater data requirements and changes to methodologies to accurately account for expected losses under the new pa- rameters. Banks may need to modify their current processes to ensure they comply with CECL’s new requirements. Transitioning will likely be a big task despite the implementation deadline being years away. CECL Background Although the details are complex, CECL is essentially a revised credit loss model that requires all banks to recognize all future credit losses expected over the life of the credit the day the loan is booked (applies to debt securities as well). The model is forward-looking and projects losses over the remaining life of a loan, as opposed to the current generally ac- cepted accounting principles (GAAP) model that estimates losses that have already been incurred as of a point in time. Under CECL, banks can generally expect credit losses to be recognized earlier than under the incurred loss model. The estimate of expected credit losses will consider historical infor- mation, current information, and reasonable and supportable forecasts. By requiring the consideration of reasonable and supportable forecasts of future events, the CECL model accelerates the recognition of credit losses as compared to current GAAP. Banks will need to record credit losses before they occur, for events they can foresee. In order to estimate future credit losses, banks will be required to have sufficient systems in place to record and analyze not just historical life- time (rather than annual) credit loss data, but also current operational and environmental data and “reasonable and supportable” future expectations related to credit quality and economic conditions. FASB does not prescribe a specific technique to estimate CECL. Instead, it allows banks to exercise judgment in determining which method is ap- propriate for it. CECL allows expected credit loss estimation approaches that build on existing credit risk manage- ment systems and processes, as well as existing methods for estimating credit losses (e.g., historical loss rate, roll-rate, discounted cash flow, and probability of default/loss given default methods). However, certain inputs into these methods will change to reflect expected credit losses and the use of “reasonable and support- able” forecasts. CECL will require operational changes at all banks, including col- lecting and analyzing the type of data that supports the modeling of the life-of-loan loss expectation, as well as forecasting and quantifying losses in the future. Nevertheless, regulators “do not expect smaller and less com- plex institutions will need to imple- ment complex modeling techniques.” 4 ALLL Though the exact amount remains unknown, the new standard is expect- ed to increase the allowance for loan